Introduction to Costs

Video Transcript

You're on a roll now, so let's keep moving. Fixed costs versus variable costs versus mixed costs. Fixed costs remain the same no matter how much you make or sell. Whether you make 100 loaves of bread or one loaf of bread, you will still pay your chef $500 per week. This employee salary is a fixed cost because it doesn't change based on the amount of bread made.

So is the $1,000 per month you pay to rent your shop. No matter how much bread you make or sell, you must still pay your landlord $1,000 each month. Therefore, your shop rental is a fixed cost. Variable costs, however, vary based on how much you create or sell. If you experience a big surge in sales, for example, like when a group of tourists land in town hungry for bread, your variable costs will increase.

Since you've gone from making 100 loaves of bread per day to 1,000 loaves of bread per day, you must buy more ingredients to make more bread. If you used to pay $10 for 100 eggs each day, and you're now buying 1,000 eggs each day, your variable cost for buying eggs alone has gone up to a $100 in total for the eggs. That is, of course, if you don't get a bulk buying deal. Finally, there's a third type of cost that isn't fixed or variable, but a mixture of the two. That's a mixed cost.

Take your chef's salary for example. You've already determined that his $500 per week salary is a fixed cost. But what if he strikes a new deal with you in order to get paid for really busy days and extra work? If you agree to pay him $1 for every loaf that he makes in excess of a 100 loaves of bread for the day, that extra bonus would be considered a variable cost because it's based on the amount of bread he makes. But the chef's total salary is now neither completely fixed nor variable, but it's a mixed cost because it contains elements of both.

It's important to know how much your costs are overall, no matter if they're fixed, variable, or mixed.